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Why Buy Copper When Gold Is Available?

February 20, 2014 By John R Taylor, Jr. Chief Investment Officer As Chinese liquidity has increased dramatically over the past decade, most notably since the monstrous stimulus package of early 2009, the stories of growing stockpiles of base metals, steel rebar, and other fungible assets have heated the airwaves. Speculation about the financing of these physical hordes and the risks inherent in them have tickled the imagination of China bashers, but we believe this process is a rational one. The retention of physical assets is a risk-minimizing strategy for companies and wealthy individuals who have few opportunities for safe investments, whether liquid or not, in an economy undergoing rapid growth with the periodic shortages and inflation bouts that come with it. In Chinas case this desire to surround oneself with real assets has probably been further increased by the countrys history and the philosophy behind the Communist system. We suspect this tendency might have been accelerated by the power changes involved with the 18th Party Congress about 16 months ago when a new team was installed and many who had exercised power and controlled substantial corporate or social assets were sent home. The many interconnections that develop within any regime are always shaken by change at the top, but when that change is within a Communist system where such an incredibly high percentage of the available power, both political and economic, is associated with the Party and that position, the shock is magnified dramatically. Stories of money flowing out of the country have circulated, but the likely response of the vast majority of the millions of successful people impacted by the Congress, would be the construction of a protective financial support net i.e. more hoarding of some kind or another. Although corporations and communes would be more likely to collect the assets of use in their economic lives, the importance of fungibility would be paramount for an individual or a family trying to protect their assets from taxes, confiscation, or the system in general. Although copper, rebar, lead, coal, and oil will still be purchased for financial protection, more pocketable assets or at least ones that dont need a warehouse like yuan notes, gold, silver, and precious stones will see an increase in demand in the years ahead. Our view is gold has qualities that make it more desirable than the others. It is very fungible easy to identify and value it is not very bulky, and it steers clear of the authorities. The horrifying experience of individual Jewish survivors from Germany and Eastern Europe starkly illustrates the value of gold and precious stones, but even in less life-threatening instances the universal liquidity of gold stands out. If you were a run-ofthe-mill Chinese multi-millionaire wouldnt you want to have 10% or 20% of your assets in gold? I know plenty of Americans and Europeans in that wealth range who feel exactly that way and they dont even have the Communist Party judging them on an ongoing basis. Being a member of the Party might even make it imperative to quietly hoard gold. ! Our low estimate for net imports of gold from Hong Kong in 2013 is about 1200 tons. But gold enters the country in many non-measurable ways by travelers, in jewelry, and through simple purchases from other sources. Considering that the World Gold Council identified total gold usage in 2013 as 3758.1 tons, Chinas slice of demand, growing at over 20% per annum, is becoming dominant. India has just recently been surpassed as the worlds largest consumer, but we would estimate Chindia' is at least 65% of global demand. These buyers are not ETF buyers who will leave if the market drops for a few months. Since late 2011, the market dropped at an annual rate of about 20%. If it rallies as it has so far in 2014, and the ETF buyers return, gold prices will go up sharply.
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What Does It Take?
By John R Taylor, Jr

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A little more than 18 months ago Mario Draghi famously spoke that the ECB would do whatever it takes to save the euro. He looks pretty good. Checking the chart out on the right, we can see his speech was the exact low for the EUR/USD, but what is more impressive is that it is also the exact wides for a large number of intra-EU bond spreads and they are still narrowing today as todays interest rate letter, Bravo e Ol, points out. But was this really the best thing for the southern periphery perhaps a lower EUR/USD would have been better than a macho German-euro. The situation bears a strong similarity with the cowboy-dollar of Ronald Reagans time, when the term rust belt came into vogue as the American heartland could no longer compete with Japan and Europe at the very high dollar levels. A strong dollar might have made Washington and New York feel good but it paralyzed certain parts of the country and they still have not recovered their market position of 35 years ago. Jut like 1985, when the Plaza Accord was drafted, something has to be done. We dont see that happening as we are not political prognosticators, but we do know the euro is too high for the health of the Eurozone.

Looking at our cyclical and technical picture, we see the EUR/USD at or very near a very major that means more than two years cyclical high, we think. There is a chance this high could come in the fourth quarter, but a very weak emerging market picture could scuttle any chance for a late year euro peak. If the global markets look relatively healthy, the chance of a strong euro into October is much higher. However, so far this year we have seen the EM struggling badly and this tends to drive us into the Draghi had better do something to save the Eurozone camp.

Our cyclical picture call for some euro strength into the end of February, but there should be a minor high in the next day or two and a bout of weakness into the first few days of March. We are expecting resistance at the 1.3810 to 1.3850 to handle the topside in the next few days, while the expected weakness into March will probably go no further than the 1.3600 to 1.3620 area. Not much excitement here. However, if the emerging currencies get into trouble there is a chance of more volatility and we would fear for the 1.3600 level in the first week of March. More likely, we will see a slow upmove into late March.

To contact FX CONCEPTS New York: 1 (212) 554-6830; London: +44 20 7213 9600; Singapore: (65) 67352898; research@fx-concepts.com